In all areas of business, it is important to carry out checks. The precise details of a transaction, the background of individuals or companies involved in any proposed deal and the origins of any money being used all need to be scrutinised in order to ensure there is no connection to criminal activity.
Such an approach is known as customer due diligence: the process of collecting and analysing all available information about the parties and / or assets in a deal to ensure there is no legal risk. It can be the know your customer (KYC) checks that financial institutions carry out on potential and existing clients.
It can also involve checks to ensure that any deal has not been set up to launder the proceeds of crime (“dirty money’’) or to be certain that the money has no links to the financing of terrorism.
There is a need to take a risk-based approach so that money or people with criminal connections can be identified before any commitment is made to a deal that may involve them. In many situations, checks will be made into the source of funds or source of wealth. This article explains what these terms mean and the law that relates to them.
What is Source of Wealth (SOW)?
A source of wealth (SOW) is a term used to describe the economic, business and/or commercial activities that generated all or part of somebody’s net worth – the money and assets that they own.
Putting it simply, it is how someone has come to have what is theirs. To take some examples, someone may have inherited a large amount of money from a relative, gained a lot from an investment opportunity that proved successful or sold a house or other high-value asset. An SOW check, therefore, is an examination of how someone obtained the wealth that they have.
Source of Funds vs Source of Wealth - What’s the Difference?
While source of wealth (SOW) means the way that someone has come to have their assets, source of funds (SOF) is something different. SOF is the term that refers to the money that is being used in a particular business transaction.
In short, the difference is:
- SOF means the money used in a specific transaction. An SOF check involves finding out where that money has come from.
- SOW refers to the money or other assets (the wealth) that someone has built up over time. An SOW check involves finding out how that person has become so wealthy.
Why are SOF and SOW Checks Important?
Both SOF and SOW checks have to be viewed as an important part of doing business. Official estimates have put the annual total of money laundering in the UK at around £10 billion[1] while other observers have said the figure could be much higher. Those who are looking to launder the proceeds of crime are always on the look-out for ways to do this – and setting up business deals is a commonly-used method.
This makes it vitally important that those in business carry out SOF and SOW checks. These checks play a major role in ensuring a company or individual does not unknowingly become involved in a deal that is being proposed for the sole purpose of laundering money.
Such checks can produce information that companies can use in their anti-money laundering (AML) and counter-terrorism financing (CFT) compliance efforts. Any information produced by these checks may also need to be reported to the authorities if it indicates suspicious activity.
Source of Funds Regulations and Obligations
As explained earlier, SOW and SOF are an important way of assessing the risk of becoming involved with those looking to use business activities for illegal purposes. But there are also legal obligations on those in business that make such checks necessary.
The UK’s Money Laundering Regulations 2017 were introduced to stop criminals using professional services to launder money. They place a number of obligations on firms that work in areas where the risk of money laundering is highest – firms who are in what is called the regulated sector:
- Regulation 28 says that companies covered by the Money Laundering Regulations must “scrutinise transactions undertaken throughout the course of the relationship (including, where necessary, the source of funds) to ensure that the transactions are consistent with the relevant person's knowledge of the customer, the customer’s business and risk profile”.
- Regulation 33 states that Enhanced Due Diligence (EDD) and enhanced ongoing monitoring (in addition to client due diligence under regulation 28) is required where:
- a high risk of money laundering has been identified.
- either party is established in a high-risk third country.
- the client is a politically exposed person (PEP), as they are thought to pose a higher than normal corruption risk.
- the client has provided false or stolen identification documentation or information on establishing the relationship.
- the transaction is complex, unusually large, is part of an unusual pattern of transactions or has no apparent economic or legal purpose.
Under the Proceeds of Crime Act 2002 (POCA), a report has to be made to the authorities if there is a suspicion that someone is engaging in money laundering. Under section 327 of POCA a person commits an offence if they conceal, disguise, convert or transfer criminal property, or remove criminal property from the UK.
When do SOF and SOW checks need to be carried out?
SOF and SOW checks need to be carried out as part of a company’s anti-money laundering (AML) compliance efforts – its attempts to ensure it is meeting all the legal obligations on it to try and identify and prevent money laundering. They are an important part of Know Your Customer (KYC) checks that financial institutions - and many other companies - need to carry out on those they have dealings with or are thinking of doing business with.
They need to be used whenever there is a need to:
- Assess a person’s financial history.
- Examine situations that may involve complex financial schemes or hidden assets.
- Check for any discrepancies in a deal or any undisclosed activities.
- Check whether information supplied is genuine.
- Assess the potential risks of money laundering or other illegal activities.
Both SOW and SOF checks are important when it comes to companies meeting their AML or KYC obligations. In simple terms, these checks need to be made whenever more information is required about a company or individual that could be involved in a business transaction.
How to Carry Out SOF and SOW Checks
Conducting an SOF or SOW check is a process that is carried out to assess the risk profile of a customer or other person or company in a transaction. It involves collecting documentary evidence, seeking and reviewing all relevant information and, importantly, documenting the entire process.
It is important that a record is kept of all the information that is provided, the checks that have been carried out and the reasons why the eventual decision was made. This will ensure that if the authorities ever start investigating, you will be in a position to show that you have done everything that was required and have met all your legal and regulatory obligations.
Should the prosecuting authorities come calling and ask about what inquiries were made, you need to be in a position where you can demonstrate that you have done everything expected of you.
SOF and SOW checks, therefore, involve taking two main steps:
- Sourcing exact details relating to the source of funds or wealth: Documentation such as the latest audited accounts (if it is a company) or bank statements (if it is an individual), reports from a reputable electronic verification service provider, the company’s website, corporate filings confirming the full names of beneficial owners and any other searches can produce the information required to decide whether the source of wealth or funds is legitimate.
- Keeping a record of everything: As mentioned earlier, a record has to be kept of all the questions asked and checks made, all the answers that were provided, and all the documentation supplied as a result of the enquiries that were made. While it will not be necessary to be able to prove you carried out a full forensic investigation, if investigations are ever carried out into the transaction or business deal (or any of the people involved in it), you will have to be able to show that all possible checks were carried out.
Identifying the risks
It is important to remember that the process is being carried out to identify any possible risks. The checks that are made are done so with the aim of seeing if there is anything suspicious about someone involved in a potential business relationship. If they do produce information that suggests there is a problem, this cannot be ignored. It may be necessary to ask further questions or seek more documentation to clarify whether there is a problem – and if there is, it may be necessary to report the matter to the relevant authorities.
High-risk clients (such as PEPs)
There will be some potential clients or customers that pose a greater risk than others.
To take one example, politically exposed persons (PEPs) are people who have held public positions in a country and are considered high-risk (along with their relatives and close associates) due to their potential influence and possible vulnerability to corruption.
Other examples include:
- Anyone who has been linked to financial crimes such as fraud, embezzlement or money laundering.
- Clients with complicated financial arrangements.
- Businesses that tend to deal in cash transactions, such as casinos or money service businesses.
- Businesses in countries that are subject to sanctions, have high levels of corruption or are linked to terrorism.
The precise circumstances and details will vary from situation to situation. But if there is anything that suggests a potential client or customer is high-risk, it will be necessary to carry out more rigorous checks. To use the legal term, you may need to carry out enhanced due diligence on that person rather than the standard customer due diligence or simplified due diligence.
Supporting documents
It has been said before in this article but is worth saying again – record all the information you ask for and obtain and keep all the documents that are presented as a result of your enquiries.
Documents such as bank statements, company records or legal papers relating to a house sale can help trace money back to its source. They may also contain information that make it necessary to ask further questions – sometimes about issues that were not apparent until the document was produced.
Conclusion
It is important that SOW and SOF checks are carried out when they are needed. But it is equally important that they are carried out in an appropriate manner. The timing of a check, the actions that are carried out as part of it, and the response to what information is produced will determine its effectiveness – and how effective a defence it can be if the authorities later start to investigate the parties or circumstances involved in any particular deal.
For some companies and individuals in business, this may seem like a challenge. They may feel they lack the experience or knowledge required to carry out such checks. If that is the case, they need to be aware that they can call on those with the relevant expertise to take on the task.
At Rahman Ravelli, our lawyers are adept at all SOW and SOF-related activities. They can advise on devising and introducing the necessary checks and procedures to ensure that those in business are able to identify and manage the risks that they face.
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